Ever since the mid-80s, the trunk
carriers in the United States have used YIELD BASED revenue models. In
layman's terms, this means that the unit cost of providing the service
often had very little relation to the unit retail pricing of that
service. In most cases, this allowed the airlines to sell a small
proportion of their seats at high yield, thus enabling them to be
competitive in the marketplace by discounting the remainder of their
inventory for discretionary sales. A flight could make money even half
full, provided that the seats occupied were the high yield variety. This
model was the backbone for developing such innovations as 3-class
product range, Frequent Flyer Programs, etc... that we often take for
granted today.
Seemingly in a parallel universe, there have also been a number of
low-cost carriers whose revenue models are LOAD DRIVEN. In layman's
terms, it means that unit retail pricing is averaged out to a narrower
range, the value of which is calculated primarily based upon unit costs.
These carriers market a much narrower product range to the passenger and
almost always offer a single class of service. As the model name
suggests, they make their money by targeting higher loads but at lower
price. There is also a strong focus on controlling unit costs, because
cost drives the retail pricing model and that must remain marketplace
competitive.
These two models targeted completely different markets in the past, but
over the last decade we have seen the carriers with the latter model
expanding their systems into a more compehensive network. Inevitably,
that means conflict between the two models. There are some markets where
the former model is more sustainable (eg. Transcontinental,
International) and others where the latter is more sustainable (eg.
Florida snowbird traffic). Whereas the discounters and niche carriers
are able to simply pick-and-choose the point-to-point markets to serve
by examining the potential acceptance of their model there, the network
carriers do not have that luxury. They command their yield premium on
the strength of their network accessibility driven by the hub-and-spoke
concept.
As a result, the onus has been on the network carriers to tweak their
business models to compete effectively with the pricing model of the
discounters. In the past, they have done so via means such as product
differentiation (eg. meals, entertainment, etc..). This product
differentiation also means incresed costs, but as mentioned above
overall unit costs and individual unit revenue bear little relation to
each other in a yield based model. As a result, a number of the network
carriers made the cardinal error of pegging their costs to the absolute
apex of revenue during the height of a booming economy. When the economy
began to go sour, their ability to attract the same high yield premiums
declined while their costs remained constant. This forced them to look
for MORE high-yield customers, who alas were simply not out there
anymore. That left them with the only option of cutting their costs by
eliminating elements of the product differentiation. As a result, their
product model began moving closer towards the discounters.
The airlines with visionary management noticed this shift in product
model early and were able to modify their pricing models concurrently to
align more closely with that of the discounters in competitive markets.
A prime example of this would be Northwest Airlines who have been
transitioning to a QUASI LOAD DRIVEN model for a few years now. Another
example, although a late entrant to the party, would be Delta Air Lines
who have experience with the latter model through their Delta Express
unit. Ironically enough, United Airlines, the airline who conceived this
theory used by others, was unable to implement it successfully with
their Shuttle by United concept. Their West Coast network had been
vulnerable early on to the discounters, primarily due to the geography
of the area. They compounded their woes by inflating their cost
structure to an absolutely unsustainable level.
The QUASI LOAD DRIVEN model which appears to be the most appropriate one
for today's environment basically segregates passengers into two
distinct groups - premium travelers and discretionary travelers. The
object of the model is to provide basic price-competitive services to
the latter group while providing additional services to the former group
and deriving a premium from them. Pricing follows seperate tracks
entirely, with the premium pricing based upon value-oriented concepts
and the discretionary pricing based upon the load driven model. This is
the model that has been very succesfully used by many European and Asian
airlines.
There is a three step process involved with implementing this model. The
first step is to DEVELOP/DEFINE the premium product, then to SEGREGATE
the premium product and finally to TRANSITION to the load based model
for the discretionary traveler. The first step of the process requires
capital outlay and brand development, the second involves a short term
revenue hit as brands realign and the third is where the payoff arrives.
UA has already made this investment in an industry-leading product such
as the First Suite, but alas have damaged the brand significantly with
cutbacks as well as the perceived "Employee Class" syndrome. Ideally,
the next step would be the product segregation. However, due to market
forces brought about by the sinking economy and the annus horribilis of
2001, UA was forced to implement stage 3 of the process ahead of the
completion of stage 2 in order to keep afloat. That means that the
transition to the load based model (which has already shown its face in
terms of consistently cheap fares in volume driven markets) preceded the
segregation process. Hence, there was an interim period where consumers
were able to take advantage of discretionary pricing to access the
premium product using benefits defined under the old yield based system.
What we are now seeing is a belated attempt to implement stage 2 of the
process while minimizing the goodwill and revenue losses that are
inevitable at this stage. UA was a latecomer to this party (AA is even
further behind, although they have begun their DEVELOP/DEFINE stage with
the shift to 2-class 767 services) and are struggling to catch up. UA's
additional problem is that their cost structure currently cannot support
a purely load driven model, meaning that they have to chop those numbers
down for this model to be somewhat succesful. It is not easy to
implement these changes sequentially at the best of times, but to be
forced into it due to the Chapter 11 process and with a clock ticking is
significantly harder, meaning more collateral damage (most likely in
goodwill) will be the result. UA is bargaining that the end model will
be strong enough for them to offset these short-term goodwill losses.
I dont think there is any question that this is the wrong TIME for UA to
be doing this. However, the ideal time would have been a long time ago
rather than anytime in the future. UA is fighting for their entire
existence right now, and they cannot persist with a broken revenue model
if they want to survive. This is an essential move in the transition to
the QUASI LOAD DRIVEN model which is their only hope for succesfully
surviving and emerging from Chapter 11. |
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